Three months of hot inflation unfortunately do make a trend… Taking stock of the money supply… Interest rate hikes might be making inflation worse… Trade ideas for the months ahead… The perfect timing for a prescient call…

By Michael Salvatore, Editor, TradeSmith Daily

Another month, another disappointingly high reading in the Consumer Price Index…

And another day of pearl-clutching price action in the U.S. stock market, as traders bemoan the likely delay of rate cuts.

Here are the highlights:

• Year-over-year, headline CPI rose to 3.5% and core CPI (sans food and energy prices) stayed at 3.8%.
• Shelter and energy costs were the biggest contributors, with the former up 0.4% over the last month.
• One bright spot was food inflation, which rose just 2.2% over the last year… and the “at home” food category rose just 1.2% (even though restaurant food costs were up 4.2%).

The S&P 500 finished Wednesday 1% lower. Gold was off by a bit less. Treasury yields surged especially at the longer end of the curve, with the 10-year reaching its highest level since November. Notably, oil rose 1% and bitcoin rose more than 2% on the day. (More on all this price action in just a bit.)

All this of course comes less as a reaction to inflation itself, and more the ever-firming idea that 2024 will see fewer than the three rate cuts the Fed projected… and most pessimistically, none at all or even a rate hike.

After what’s now three straight months of hotter-than-expected inflation numbers, you’d think it would stop surprising Wall Street. Did anyone really think a single year of interest rates above the rate of CPI would fling us right back down to the glorious pre-pandemic days?

Did they really think the Fed would cut rates even as the bond market has been selling off for the past three months?

And did they really think there could be a full 3.2 trillion more dollars in the economy than there just were five years ago – a 70% increase – and things would rebound back to normal in no time flat?

❖ To visualize that number, let’s look at the Fed’s balance sheet…

Here it is…

This chart represents the assets the Fed holds on its balance sheet, using money it “prints out of thin air” and hands over to banks. The banks then keep the money in reserves.

The majority of these assets are government bonds, but a good chunk of it is mortgage-backed securities. As the assets mature, the Fed opts not to reinvest and takes back its principal from the bank, where it then effectively “vanishes” back to where the Fed printed it originally.

This chart is perhaps the best analog we have for the overall money supply in the economy. It’s also the Fed’s second “lever” – or tool for managing monetary policy.

We can see the Fed’s been busy letting its balance sheet run off. It’s shrunk the U.S. money supply by roughly $1.5 trillion from the 2022 peak. But that’s taken nearly a year and a half, and there’s still $3.2 trillion to go.

If we want to think about this linearly, we can expect the money supply to return to pre-pandemic levels in 2027. That, of course, is if everything goes smoothly and there’s no additional crisis between now and then that demands the Fed stimulate the economy.

And let’s hope there isn’t. Because the Fed’s primary lever for guiding monetary policy may be doing more harm than good.

❖ Higher interest rates are, get this, inflationary…

That noise you hear is the sound of the Fed’s interest-rate lever snapping in two.

According to JPMorgan’s Jack Manley, higher mortgage costs brought on by interest rate hikes are the key driver behind rising shelter costs. Here he is speaking to Bloomberg:

“You’re not going to see meaningful downward pressure on shelter costs until the Fed lowers interest rates, mortgages come down to a more reasonable level, and supply comes back online, because people are willing to step into that market,” Manley said.

With rates so high, few homeowners are willing to sell and “trade up” or relocate. This stifles housing supply.

And for renters, landlords are passing higher lending costs – along with high home insurance costs – on to tenants.

So, in a twisted sort of way, the biggest contributor to the most recent inflation readings – shelter costs – won’t go down until the Fed lowers rates. But the broader picture of inflation reaccelerating tells the Fed to do the opposite. Another rock, another hard place.

Okay, all this macro-talk is good and all, but let’s talk turkey. Where should you put your money amid all this?

❖ Frankly, the gameplan hasn’t changed much…

The broad stock market is certainly under pressure and may be entering a down period over the next month and change. And that’s not just our gut talking – that’s the word from the Trade Cycles Seasonality tool:

From today, April 12, through the end of next month, the S&P 500 produces an average return of just 1.9% during election years, with a 57% accuracy rate.

After that, we can see a pronounced down period from around the middle of June… and then a big surge higher in the summer.

Thus far in 2024, stocks haven’t experienced the first quarter volatility we’ve traditionally seen in election years. On average, stocks suffer through the month of March. This time around, they mostly kept pace higher.

All told, though, you probably won’t see great returns from investing in the S&P over the next couple months.

But what we can do is look to other sectors that have been doing well… and are set to continue doing well according to history.

Take the energy sector. Here’s the Trade Cycles Seasonality indicator applied to the energy sector (XLE), also during election years.

In the past seven election years, XLE returned an average of 5.81% with an 83% accuracy rate from today through the end of May.

And while gold miners (GDX) tend to trade flat from now through the end of May, looking out to July, we see a much bigger surge in store – an average return of 12.5%, though at a coin-flip 50% accuracy rate:

We always like to say at TradeSmith that you should never rely on one indicator in a vacuum. It should be used in conjunction with other indicators to confirm trade ideas.

I’m confident gold and oil will make for great trades over the next few months, though for different reasons.

For gold, we’re simply seeing new highs in the metal itself and a resurgence in the price of gold mining stocks. New highs tend to beget new highs. Beyond that, the current macro picture of high inflation and worsening conflicts overseas favor flights to safety in the yellow metal.

Oil, too, has additional seasonal tailwinds. Oil almost always goes up ahead of the summer travel season, as fuel demand rises for road trips and flights abroad alike.

For a way to play it, consider some call options on GDX and XLE dated a couple months out. Those might do well if seasonal trends play as we think they could.

And on the downside, you could play the relative weakness in stocks with some put options – or buy inverse ETFs for the short term.

Trade Cycles editor William McCanless just recommended the latter trade to his subscribers, and then followed up with his full gameplan for the month of April.

❖ One man called higher rates for longer before most others…

Even just a few weeks ago, the idea that the Fed would break from its projections and not start hiking in June was hard to believe. Now, it’s the consensus.

But one expert analyst, who I’ve had the pleasure of knowing and working with in the past, connected the dots ahead of the crowd.

His name is Charles Sizemore. I’ve shared a few of his thought-provoking ideas here with you in TradeSmith Daily – and with his permission, recently shared a trade idea from his investment advisory, Freeport Investor.

On Wednesday night, Charles Sizemore and legendary stock-picker Louis Navellier unveiled Charles’ premium investment advisory, Freeport Alpha.

In Freeport Alpha, Charles uses an ingenious system to track money flow in the markets. With it, he can zero in on quality stock opportunities in the trends flying under the radar.

Central to Charles’ thesis is the idea that inflation is here to stay for longer than many hope or expect. And, because of this, the election chaos about to ensue will be bigger than most anticipate, as well.

That’s why he’s recently recommended four brand-new stock plays and one option trade to make ahead of the U.S. election, in addition to three can’t-miss trades to make before the next Fed meeting on May 1. (Paid-up subscribers can read the latest on those trades here.)

To your health and wealth,

Michael Salvatore
Editor, TradeSmith Daily